Reading 26- Financial Analysis Techniques

Question 1

Describe tools and techniques used in financial analysis, including their uses and limitations.

Answer 1

Tools and techniques? All we do is have a bunch of ratios that we use. (liquidity ratios, solvency ratios; activity ratios, profitability ratios, valuation ratios)

1. ) Ratios Analysis
2. ) Common-Size Analysis
3. ) Graphical Analysis
4. ) Regression Analysis

Question 2

Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.

Answer 2

Activity Ratios

• Receivables Turnover
• Days of Sales Outstanding
• Inventory Turnover
• Days of Inventory on Hand
• payables turnover
• number of days payable
• total asset turnover
• fixed asset turnover
• working capital turnover

Liquidity Ratios

• Current Ratio
• Quick Ratio (AR)
• Cash Ratio
• Defensive Interval

Solvency Ratios

• Debt to Equity
• Debt to Capital
• Debt to Assets
• Financial Leverage
• Interest Coverage
• Fixed Charge Coverage

Profitability Ratios

• net profit margin
• gross profit margin
• operating profit margin
• pretax margin

Valuation Ratios

• return on assets
• operating return on assets
• return on total capital
• return on equity
• return on common equity

Question 3

Describe relationships among ratios and evaluate a company using ratio analysis.

Answer 3

Each ratio has its set purpose; please use all ratios together to understand a better picture of the story.

Question 4

Demonstrate the application of DuPont analysis of return on equity and calculate and interpret effects of changes in its components.

Answer 4

3 step DuPont Analysis (valuation of a company):

Return on equity= (net income/total equity)* (sales/sales)
= (net income/sales revenues)*
(sales revenue/total equity)*
(assets/assets)

Return on Equity= (NI/sales revenue)(sales revenue/assets)(total assets/ equity)

• ROE= FINANCIAL LEVERAGE * ASSET TURNOVER * PROFIT MARGIN*

5-STEP DUPONT

ROE= (net income/sales revenues)*
(sales revenue/total equity)*
(assets/assets)* (EBT/EBT)*(EBIT/EBIT)

ROE= SALES/ASSETS * ASSETS/TOTAL EQUITY * EBT/EBIT* EBIT/SALES REVENUE * NET INCOME/EBT

Question 5

Explain the requirements for segment reporting and calculate and interpret segment ratios.

Answer 5

Segment Reporting is creating a financial report for a separate entity attached to large parent company. Requirements include the following:

1. ) Profit Center
2. ) CEO reviews financial info regularly
3. ) Used to breakup one large consolidated financial report into branches of financial reports that can be used to monitor a segment of the business.

Question 6

Describe how ratio analysis and other techniques can be used to model and forecast earnings.

Answer 6

Ratio analysis and other forms of analysis are used to create a PRO-FORMA STATEMENT:
A.) In order to get a pro-forma or future outcome, you need to analyze previous ratios

B.) Use ratios to complete a sensitivity analysis like a “what-if-analysis” to see what factors are sensitive

C.) Then, you need to complete a scenario analysis to see how external environmental and economic factors can affect the pro forma income statement

D.) PRACTICE with EACH PRO FORMA STATEMENT with Business Simulations

Question 7

Calculate and interpret ratios used in equity analysis and credit analysis.

Answer 7

Credit Analysis=
assessing a company’s ability to service and repay debt, analysts uses interest coverage ratios, return on capital, debt-to-assets ratios

Equity Analysis= CV analysis

SD OF SALES/ MEAN SALES = CV SALES

SD OF OPERATING INCOME/ MEAN OPERATING INCOME= CV OPERATING INCOME

SD OF NET INCOME/MEAN NET INCOME = CV NET INCOME